Markets & Finance

Currencies: Playing a Rebound in the Pound

Is it time to buy sterling? That depends on what you make of the dangers facing the struggling British economy

"The pound is sinking," sang Paul McCartney in 1982. Unfortunately, the ex-Beatle's ditty would sound perfectly current on a 2009 playlist. The near-nationalization of the Royal Bank of Scotland on Jan. 19—in which the British government boosted its stake in the ailing banking giant to 70%—sparked fears for the health of the British banking system and forced the British pound down 6.6% for the week ended Jan. 23. As of Jan. 27, the venerable currency was worth $1.42 and €1.08, well off its peak of $2.11 and €1.53 in 2007.

So is now a good time to buy the pound?

That depends on what you make of the dangers facing the struggling British economy. Britain faces a full-blown bank nationalization, and some critics insist its economic pain is just beginning. These analysts argue that England's economy is too weak and too dependent on financial services to weather the storm. Joseph Trevisani, chief market analyst at FXSolutions, cites the enormous British debt load, the destabilizing effect of upcoming elections, and a history of trading volatility as negatives for the currency. "Unfortunately for the British public and the government, not one major criterion is positive for the pound," Trevisani wrote in a Jan. 26 report.

Dissent in the Euro Zone

Noted investor Jim Rogers went a step further in an interview with Bloomberg on Jan. 20: "I would urge you to sell any sterling you might have. It's finished. I hate to say it, but I would not put any money in the U.K."

Not so fast, say others, who look at the beaten-down currency and see opportunity. For starters, they contend, Britain's not alone in this mess. The U.S. banking system is in dismal shape, and the government may be forced to initiate its own wave of nationalization. The euro zone, under pressure from ratings downgrades of the sovereign debt of some of its smaller members, is facing internal dissension that could splinter the European monetary union. Japan has benefited from the end of the "carry trade," under which savvy global investors borrowed yen at low interest rates to buy higher-yielding currencies, but the strong yen has made Japanese exports virtually unsalable abroad.

With all the trouble outside the Sceptered Isle, some think the pummeling of the pound is overdone. "The sell-off in sterling has been much greater than relative prospects would suggest," says Barclays Capital (BCS) Chief Sterling Strategist Paul Robinson.

Sterling Could Beat the Greenback

The fundamentals weighing on the British currency are plain, but technical factors may also shed light on the sterling's fall. Whether due to a flight to safety or because dollar- and yen-denominated debt needs to be paid back, which entails selling weak local currencies to buy strong foreign ones, or because traders are simply going with momentum, there's a lot of selling going on. But as investors begin to renew their focus on the problems of other economies, the pressure on sterling may ease. The selling could turn to buying if investors suddenly decide they'd rather take a little risk to earn return, rather than watching their cash evaporate.

The bottom line? "Over the course of this year, markets are likely to function more normally," Barclays' Robinson says. "When this happens, sterling will outperform safe haven currencies like the dollar."

Investors who think the pound will rise against the dollar can go a number of routes. For a relatively straightforward, traditional banking product, EverBank offers a certificate of deposit denominated in pounds. The purchase price, however, does not necessarily reflect the current market price of the currency—the prospectus for the CD states that it may deviate by as much as 1%. An EverBank six-month British pound sterling CD offers a 0.5% rate of return, as well as any appreciation (or depreciation) in the currency.

ETFs Could Outperform

For investors who prefer more a liquid investment, the CurrencyShares British Pound Sterling Trust (FXB), an exchange-traded fund that holds actual currency, could be a better option. For the cost of a trade, bulls can purchase shares in the fund and effectively get a price close to what the currency fetches in the spot market—and exit just as easily. And if you're still not convinced the pound is on the way up, the CurrencyShares British Pound Sterling Trust can be shorted just as easily.

Says Penn Financial Group President Matthew D. McCall, who specializes in ETF trading: "I use them just as I would if I were trading the currency on a futures exchange."

Given the volatility in currency markets, the pound's role as the currency global investors love to hate may not last long—and savvy investors may have an opportunity to sing a happier tune.